An Erosion of Confidence in China

31 July 2015

“There is no Alan Greenspan or Mario Draghi in China,” said Peng Junming of Beijing-based Empire Capital Management, referring to the former chairman of the Federal Reserve and the current president of the European Central Bank. Peng, a former official of the People’s Bank of China, highlighted one weakness of his country’s financial system. When stocks started to slide in June, no top official appeared in front of the cameras to reassure nervous investors.

The Wall Street Journal thinks Beijing’s silence is significant. “The rescue effort is missing one feature found in markets elsewhere: a senior figure stepping forward to stop the panic,” the paper noted on Tuesday.

There are, in fact, leaders who the Chinese people see with some regularity, namely the general secretary of the Communist Party, Xi Jinping, and the premier of the central government, Li Keqiang. Neither Xi nor Li, however, has gone on the record over the stock rout.

Is that the problem? Could a Greenspan-like figure help inspire confidence in Beijing’s management of share markets? Perhaps, but the fundamental problem is less the presence of a spokesperson than the nature of the Chinese system itself.

The Journal itself points to a lack of institutionalization in China. In fact, there are no independent Chinese institutions. The People’s Bank of China, always referred to as the country’s central bank, has no independence. It reports to the State Council, and in reality it carries out policy made by the Communist Party’s Leading Group on Finance and the Economy.

Zhou Xiaochuan, the respected governor of the PBOC, merely executes the non-transparent Leading Group’s decisions. For instance, for many months he has been carrying out loose-money policies that he consistently opposed in the past. And in recent weeks he also implemented the universally criticized stock rescue plan, which he apparently argued against. It does not matter that Zhou’s cautious views have generally been proven right; month after month he has been forced to put in place ill-considered stop-gap measures mandated by officials at the top of the Chinese political system.

The China Securities Regulatory Commission, like the central bank, also serves as a front for Party leadership. There have been rumors for weeks that its chairman, Xiao Gang, will be removed for failing to prevent the stock slide that began in mid-June.

In one sense, his removal would be an injustice. The plunge in prices was the inevitable result of the Party’s ploy a year ago to spike a steep rise in stocks. The idea was that an increase in share values would stir consumption—the so-called “wealth effect”—and permit enterprises to issue stock so that they could pay off heavy debt loads.

The plan worked for a while. Share prices as measured by the Shanghai Composite rose more than 150 percent from the beginning of July 2014 to the middle of this June. But the reckless tactic was bound to end in a collapse because the rally was not supported by either an increase in GDP growth or a surge in corporate profits. Stocks went up almost entirely because the Party exhorted the Chinese people to buy equities, and they fell less because of Mr. Xiao than because the bubble, inevitably, had to burst.

The Communist Party, despite its November 2013 commitment to let markets play a “decisive” role, has made it clear it will set equity prices. Its stock rescue plan, rolled out in announcements made July 4th and July 5th, was not only interventionist but dictatorial, even establishing a price target for the Shanghai Composite with mandated buying and holding of stocks.

The plan initially succeeded to arrest the slide, but the sharp and unanticipated fall on July 27th—the Shanghai Composite lost 8.5 percent that day in the second-largest drop in its history—shows how jittery China’s investors remain despite repeated government assurances and intervention.

The Financial Timesreports that Monday’s plunge was caused because investors did not believe the central government would stick with its market-support plan.

At this point, Beijing’s problem is that the Chinese people have lost confidence, and not just in the economy, but also in the Party and its capacity to run the country. Capital outflow, for instance, has reached levels unimaginable just a year ago. According to a recent estimate, about $800 billion has left China in the past 12 months. In contrast, a few years back money was flooding into China, hoping to take advantage of a rising renminbi and robust growth.

Moreover, study after study show that the Chinese want to live elsewhere. A stunning 47% of China’s wealthy plan to leave China in a half decade according to a Barclays survey released in September.

Ultimately, it’s not clear what caused the underlying shift in attitudes, but it looks as if the shift has finally affected stock prices. In these circumstances, it’s unlikely that any figure, whether a Zhou or Xiao or Xi or Li, can inspire the populace to buy or hold stocks.